TECHNICAL
TABLE 1 Years 1 + 2 + 3 + 4
= £39,500 (used to recoup investment)
In Year 5 amount needed to recoup investment in full = £40,000 - £39,500 = £500
Months in Year 5 before investment fully recouped = £500
£12,000 x 12
Net cash flow over 5 year project = £51,500
Total net cash flow (after payback)
Example 2 - installation of a borehole to replace mains water for irrigation
Project B requires an initial investment of £40,000 and is forecast to yield the following net cash flow figures in water savings: Year 1
2 3 4 5
Net Cash Flow 5,000 5,000 6,000 6,000 7,000
(See table 2)
With this project, the initial investment would not be recouped after 5 years. This does not preclude the project, as ongoing savings may be deemed worth pressing ahead.
Example 3 - drainage of three fairways that causes regular closure of the course during the winter and loss of green fees.
An initial investment of £40,000 into Project C will lead to the following net cash flows: Year 1
2 3 4 5
Net Cash Flow (4,000) 9,000 13,000 16,500 18,000
(See table 3) Payback is the most frequently
TABLE 4
Proposal A Cash Cost
1 9,000 2 9,500 3 10,500 4 10,500 5 12,000
Avg annual cash savings 10,300
Payback 4 years 0.5 months 126 PC December/January 2020
Proposal B Cash Cost
£40,000 £40,000 Savings Savings 5,000 5,000 6,000 6,000 7,000
5,800
Proposal C Cash Cost
£40,000 Savings (4,000) 9,000 13,000 16,500 18,000
10,500 Not achieved 4 years 4 months = £51,500 - £40,000 = £11,500
able 4shows how to evaluate the above projects using payback as the selection criterion. The cash inflows and outflows for each are shown. The payback period can be of some use in screening the three proposals. Proposal A seems to be better than Proposal C - the shorter payback period is clearly better. Proposal B can be excluded outright - its initial cost exceeds future cash savings, so it does not pay for itself. Therefore, with payback, Proposal A is accepted. This method has several shortcomings that limit its usefulness. First, the method does not consider the earnings that continue after the payback period is reached. Proposal C, for instance, has a total savings of£52,500 in comparison to the £51,500 total earnings of Proposal A.
applied technique, which is used to screen out projects that would take too long to recoup the initial investment. A more accurate method of investment appraisal would then be used. T
= 0.49 months
TABLE 3 Years 1+ 2 + 3 + 4
= £34,500
In Year 5 amount needed to recoup investment in full = £40,000 - £34,500 = £5,500
Months in Year 5 before investment fully recouped = £5,500 x 12
£18,000
Net cash flow over 5 year project
Total net cash flow (after pay back)
of the cash savings for each proposal when using this payback approach.
2.Average Annual Return Due to unpredictable
fluctuations in returns over the life of a project, average return is often used as a slightly more accurate measure in investment appraisal. The total return (net cash flow) is averaged over the duration of the project. The average annual return can also be converted into a percentage in relation to the value of the initial investment. Both these figures can be used as a basis of comparison for different investment proposals.
The slightly shorter payback of Proposal A may mislead the manager who relies solely on the payback approach to evaluating investments. Also, keep in mind that we are ignoring the time value of money
The average annual return percentage should initially be compared with the business's cost of capital (explained in Discounted Cash Flow).
Example 1
Using the figures for Project A, which had an initial investment of £40,000:
TABLE 5
Average return = Total Return = £51,500 = £10,300 Years 5
Average return % = Average return = £10,300 x 100 = 25.75% Investment £40,000
TABLE 6
Average return = Total Return = £52,500 = £10,500 Years 5
Average return % = Average return = £10,500 x 100 = 26.25% Investment £40,000
= £46,000 = £52,500 - £40,000 = £12,500
Year Net Cash Flow 1
2 3 4 5
9,000 9,500 10,500 10,500 12,000
(See table 5) Example 2
Using the figures for Project C with an initial investment of £40,000: Year 1
2 3 4 5
Net Cash Flow (4,000) 9,000 13,000 16,500 18,000
(See table 6) 3. Net Present Value
Both Payback and Average return have a major drawback in that they ignore the 'time' factor, i.e. £1 received today is worth more than £1 received in one year’s time.
The Net Present Value is the net value of the future cash flows, i.e. the value of the future total cash value flow minus the
= 3.6 months
TABLE 2 Years 1 + 2 + 3 + 4 + 5
Throughout 5 year project
Total net cash flow (after payback)
= £29,000 = £29,000
= £29,000 - £40,000 = (£11,000)
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32 |
Page 33 |
Page 34 |
Page 35 |
Page 36 |
Page 37 |
Page 38 |
Page 39 |
Page 40 |
Page 41 |
Page 42 |
Page 43 |
Page 44 |
Page 45 |
Page 46 |
Page 47 |
Page 48 |
Page 49 |
Page 50 |
Page 51 |
Page 52 |
Page 53 |
Page 54 |
Page 55 |
Page 56 |
Page 57 |
Page 58 |
Page 59 |
Page 60 |
Page 61 |
Page 62 |
Page 63 |
Page 64 |
Page 65 |
Page 66 |
Page 67 |
Page 68 |
Page 69 |
Page 70 |
Page 71 |
Page 72 |
Page 73 |
Page 74 |
Page 75 |
Page 76 |
Page 77 |
Page 78 |
Page 79 |
Page 80 |
Page 81 |
Page 82 |
Page 83 |
Page 84 |
Page 85 |
Page 86 |
Page 87 |
Page 88 |
Page 89 |
Page 90 |
Page 91 |
Page 92 |
Page 93 |
Page 94 |
Page 95 |
Page 96 |
Page 97 |
Page 98 |
Page 99 |
Page 100 |
Page 101 |
Page 102 |
Page 103 |
Page 104 |
Page 105 |
Page 106 |
Page 107 |
Page 108 |
Page 109 |
Page 110 |
Page 111 |
Page 112 |
Page 113 |
Page 114 |
Page 115 |
Page 116 |
Page 117 |
Page 118 |
Page 119 |
Page 120 |
Page 121 |
Page 122 |
Page 123 |
Page 124 |
Page 125 |
Page 126 |
Page 127 |
Page 128 |
Page 129 |
Page 130 |
Page 131 |
Page 132 |
Page 133 |
Page 134 |
Page 135 |
Page 136 |
Page 137 |
Page 138 |
Page 139 |
Page 140 |
Page 141 |
Page 142 |
Page 143 |
Page 144 |
Page 145 |
Page 146 |
Page 147 |
Page 148
